Congloms wary, but climate could spur new wave

The bruising recession of the past two years clearly has left its imprint on the entertainment business, with spending going from profligate to prudent. Companies are hoarding unprecedented amounts of cash, choosing more often than not to deploy it in the least sexy ways possible: buying back shares or increasing dividends.

That may not be good news for a producer or filmmaker angling for coin on their next project, but for shareholders of the media conglomerates, this new balance-sheet discipline is golden. Investors are seeing healthy gains on their stakes in media and entertainment after trailing the broader market for years.

For the past 12 months, the Bloomberg Media Index — which measures the collective performance of 33 media companies of all types, from Time Warner and Comcast to the McGraw-Hill companies — posted returns of 24%, vs. 5% for the Standard & Poor’s 500 Index.

You don’t have to look any further than Time Warner to see how times have changed.

Two years ago, CEO Jeff Bewkes gave his approval for the $850 million purchase of U.K-based social networking site Bebo, which had yet to earn a penny in profit. The deal was roundly criticized by Wall Street, and Bebo was quietly jettisoned from Time Warner last year as part of the spinoff of AOL.

Fast forward to 2010. So far this year, Time Warner has spent all of its free cashflow — about $1.5 billion — buying back shares or issuing dividends (which it raised by 13%). During the spring, it offered $1.5 billion to buy MGM, a deal that seemed to make great sense as complementary to the company’s Warner Bros. studio operations. But when MGM balked at the price, Bewkes and his team refused to raise the ante.

The collapse of Lehman Bros. on Wall Street two years ago this month underscored the severity of the economic downturn, and it may have been the first inkling that some moguls were about to get religion. In the weeks following, Madison Avenue tightened its belt in earnest and a major source of revenue for the media sector fell off a cliff.

As the credit markets tightened their grip, Sumner Redstone was forced to sell off shares in his beloved Viacom and CBS to help make debt payments at his parent company, National Amusements. The move, however painful, allowed Redstone to retain control of the two media giants.

“In view of how sudden and dramatic this recession was, you begin to see a movement to hunker down on the part of executives and to be more fiscally conservative,” says media analyst Anthony DiClemente of Barclays Capital.

DiClemente says a lot of media execs came to the realization that it no longer made sense to do highly leveraged acquisitions and “that it was better to repay debt or keep cash on hand.”

In a recent report, DiClemente projects that cash balances at media companies will continue to rise, from $18.5 billion in the second quarter to $23.3 billion at year’s end.

It could be that the Hollywood lexicon of “blockbusters” and “tentpoles” will now include “return of capital” — what you give back to shareholders, in other words.

The deals that Time Warner has done of late are largely strategic, tuck-in acquisitions, like buying full ownership of some international HBO channels, purchasing a Chilean broadcaster and snapping up Turbine, an online gaming studio. They may not be the most exciting, but the pacts speak to a new sensibility.

Consider one of Time Warner’s major talking points during its Q2 earnings call in August. “Our returns (to shareholders) on a year-to-date basis are basically double a level they were a year ago,” CFO John Martin pointed out.

But analysts are projecting that year-over-year revenue gains in media and entertainment will slow, raising the question of whether that will put more pressure on execs to do deals as a way to tack on new revenues.

Media have always been one of the most active industries for deals, but the results are often less-than-stellar. Fee-hungry investment bankers surely yearn for yesteryear, when big outfits like Disney and Capital Cities joined forces, or Viacom and CBS merged (only to part ways), or when NBC bought Universal. Even deals like News Corp.’s $5.6 billion buyout of Dow Jones in 2007 and CBS’ $1.8 billion purchase of CNET seem like a distant memory.

“A lot of this cash now on the books will unquestionably create temptation,” says media investment banker Jonathan Knee, a senior managing director of Evercore Partners. “But these days mitigating the temptation to do deals is a healthy level of skepticism among shareholders about media’s record on deals.”

Knee, co-author of “The Curse of the Mogul: What’s Wrong With the World’s Leading Media Companies,” a book that takes media execs to task for creating a myth that deals are indispensable to their businesses while masking poor financial performances, says execs are finally coming to the realization that it is not size but growth that is important.

“What you see now are a lot of content assets that can’t deliver adequate growth,” he says. So if media companies go after those kinds of assets, it will only dilute their earnings.

Digital assets are showing more growth, but the largest of those properties that might make sense as a buyout target, such as a Netflix, would attract a price that would lead to shareholder revolts, says Knee. “So then you have smaller digital assets, but they just don’t move the needle,” he adds.

Of course, the deal front is not stagnant. Comcast’s $13.75 billion offer to buy a majority of NBC Universal is still awaiting regulatory approval and will be closely watched by those skeptical of the content-marrying-distribution model. And in the past year Disney has been both buyer and seller, purchasing Marvel Entertainment for $3.8 billion and the social-gaming business Playdom for $763 million, while selling its Miramax Films unit for $660 million to a group led by construction magnate Ron Tutor.

The recession has not been kind to any industry, but it has walloped media at an inflection point where old models were showing their obsolescence and new digital models were still unproven, arguing against greater investment.

What the industry will soon find out is whether it can remain prudent and shareholder-friendly while forging its future growth at the same time.